Resources gloom on latest China figures

The last thing Australian resource companies and global commodities markets needed was bad news from China. The slump in iron ore and coal prices has already severely undermined confidence in the resources sector.

Now, the first contraction in official Chinese manufacturing for nine months will knock this confidence even lower.

China’s official factory purchasing managers’ index fell to a lower-than-expected 49.2 in August from 50.1 in July, official data showed on Saturday. A PMI below 50 indicates contraction in Chinese manufacturing; it is the first contraction since November 2011.

It has been China and only China that has kept hopes alive that the resources boom may well have had more time to run.

AFR
AFR

But the Chinese manufacturing data, while not a game stopper, is certainly another nail in the coffin for the resources boom.

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The official PMI follows the interim, or flash, PMI published by HSBC two weeks ago which plunged to a nine-month low of 47.8 in August because of falling new export orders and rising inventories.

However, an immediate commodity price rout may be held off because miners and investors will see the poorer manufacturing data as an incentive for Chinese policy makers to instigate an easier monetary policy regime and perhaps even a round of fiscal stimulus.

This is certainly how investors in Western markets are taking the bad news. The worse the news, the more bullish it is seen to be, because it increases the chances of liquidity injections by the world’s central banks. But whether such injections actually help reduce unemployment and indebtedness is another matter. They haven’t so far.

PMI data is forward looking and the poor August number, and other weaker than expected July data, indicates the Chinese slowdown is more persistent than expected and could go into the fourth quarter. That was when most analysts expected a recovery in the Chinese economy towards 8 per cent annual growth compared with 7.6 per cent in the second quarter, the slowest pace in more than three years.

Spot iron ore and coal prices have fallen by a third in the past four months. Higher cost miners, such as
Fortescue Metals
, could be in trouble, perhaps a lot of trouble, if the price slides lower and doesn’t recover.

Some expect the iron ore price to slide another 20 per cent to about $US70 a tonne, but most miners continue to talk it up on the basis of a recovery in Chinese demand later this year as Chinese high cost iron ore producers shut down.

It is likely the Chinese Communist Party, which is dependent on growth and the provision of greater economic opportunities for its people, will stimulate growth if it slips much lower.

But whether this increases steel production and the demand for iron ore is another issue.

The conventional wisdom is that China’s per capita steel consumption and hence iron ore consumption remains very low and is set to rise. Growth is, in effect, seen to correlate directly to significantly higher steel production.

This has been the mantra of Australia’s miners. But looking at steel consumption per unit of gross domestic product rather than per capita tells a very different story.

China’s steel consumption per unit of GDP is in fact very high. This is also the case for most metals. China’s metal consumption generally per unit of GDP is high.

For the same amount of GDP, China is already using much more steel, copper and aluminium than most other countries (see charts).

So the argument pushed by
BHP
,
Rio Tinto
and others that China is on a natural path to consuming a billion tonnes of steel by 2020, up from 630 million tonnes today, because China’s current low per capita consumption rate enables this expansion, is questionable.

The primary driver of the rise in steel consumption of about 140 million tonnes over the past three years has been the massive fiscal stimulus by the Chinese government back in early 2009.

This saw a surge in resource-intensive fixed asset investment. This is now petering out.

New stimulus programs, if they are instigated, are not expected to be as large as that 2009 program. They will increase steel consumption, but at nothing like the rates of the great stimulus of 2009. Chinese authorities are also trying to rebalance growth away from fixed asset-driven growth towards consumption-driven growth.